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The sound of $885b being sucked into China

Concerns about Chinese influence in politics and universities may be at fever pitch, but the reality is that some of Australia’s retirement savings will help fuel a predicted $US600 billion ($885 billion) inflow into mainland stocks over the next decade.
Robert Guy
Nov 27, 2019

Concerns about Chinese influence in politics and universities may be at fever pitch, but the reality is that some of Australia’s retirement savings will help fuel a predicted $US600 billion ($885 billion) inflow into mainland stocks over the next decade.

That expected flow of foreign capital has received another boost. Index compiler MSCI implemented the latest phase of the inclusion of Chinese stocks into its closely watched China and emerging markets index, an important milestone HSBC estimates could trigger $US5.5 billion worth of A-shares buying over the next two weeks.

A-shares, or those stocks listed on mainland exchanges in Shanghai and Shenzhen, will now have a weighting of 12.1 per cent (up from 7.9 per cent) in the MSCI China Index and a 4.1 per cent weighting in the MSCI Emerging Markets Index.

The latest round of MSCI changes will also see 204 A-shares, including 22 from the tech-laden ChiNext market, added to the MSCI China Index. This brings the total A-shares included to 472. And there is more to come.

Another index compiler, FTSE Russell, will increase its A-share weighting to 25 per cent from 15 per cent in March 2020, which HSBC reckons could send another $US4 billion into mainland stocks.

The changes are important as it will force passive – or index-focused – investors to increase their weighting of Chinese stocks, while active investors will have to give more thought to how much they want to be overweight or underweight a market that is growing in importance.

HSBC is right to argue that ‘‘China is a market too big to ignore’’ and it’s not surprising they estimate that a sharpened focus on Chinese stocks could attract $US600 billion of foreign funds into China over the next five to 10 years given the size of the opportunity.

China is understandably on the radar of some of the world’s smartest investors despite growth slowing to 6 per cent – its slowest pace in 30 years.

Speaking at last week’s Sohn Hearts and Minds investment conference, Bridgewater Associates founder Ray Dalio and Oaktree Capital Management founder Howard Marks spoke positively of investing in China.

Marks says China will grow strongly for decades and therefore ‘‘you probably want to have some significant investment there’’.

Chinese stocks have performed strongly over the past year. The CSI 300 Index, which includes stocks traded on the Shanghai and Shenzhen exchanges, is up 42 percent–less than the 51 percent return delivered by the US S&P 500 Index, but ahead of the 24 per cent gain from Australia’s S&P/ASX 200 Index.

Australian investors aren’t isolated from the rise and opening up of Chinese stock and bond markets, and their inclusion in widely followed benchmarks used by fund managers.

China has steadily transformed its financial markets over the past five years. The opening up of the Shanghai- Hong Kong and Shenzhen-Hong Kong stock connects, as well as the Bond Connect, have all been important parts of Beijing’s reform agenda aimed at deepening its capital markets.

There is still a long way to go. Donald Trump is reportedly threatening to limit capital flows into China, while there are also technical issues like the availability of hedging tools and derivatives that need to evolve to attract more institutional investors.

China’s bond market – the world’s second largest – will also become a magnet for foreign funds.

Chinese bonds were earlier this year included in the closely followed Bloomberg Barclays Global Aggregate Index with a 6 per cent weighting.

China bond market bulls like UBS Asset Management’s Hayden Briscoe reckon that if the index changes – and China’s likely addition to other bond benchmarks – were implemented now, it would be equal to a $US500 billion inflow into Chinese bonds.

In a world where there is $US12.4 trillion of negative-yielding debt, Chinese 10-year bonds with a yield of 3.18 per cent may look alluring to investors with a stomach for risk.

There is no doubt China is still a relatively risky market; it can turn on the latest diktat from Beijing and is still struggling to deal with a massive debt binge. But in a world marked by low and slowing growth in the west, the combination of relatively stronger growth and more policy flexibility may prove too enticing.

This article was originally posted on The Australian Financial Review here.

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